To achieve growth of 5.5% by 2016, RGMs will need to achieve a political consensus around economic reform.

Certain RGMs have made significant progress in addressing their medium-term sustainability.

Financial turmoil adds to challenges

Alongside the disappointing economic data, RGMs have been buffeted by considerable instability in financial markets. This was partly caused by expectations that the US Federal Reserve would start to taper quantitative easing and that there would be a rise in US bond yields.

But instability also reflects heightened unrest in the Middle East and concerns over structural weaknesses across a number of RGMs.

Turmoil in the financial markets has added to the challenges that rapidly growing economies face, and many of them look vulnerable to further short-term pressures.

These factors have brought about a flight from riskier assets.

The effects of this have been:

Sharp drops in RGM currencies — The currencies hit hardest have been those with particularly wide or deteriorating current account deficits, such as South Africa, Turkey, Indonesia and India. While some currencies are now recovering, there will be an impact on inflation this year. Some markets are still vulnerable to pressures on their current accounts.

Emergers: exchange rates vs. US$

Source: Haver Analytics.

Sharp rise in bond yields — Government bond yields in many RGMs have risen sharply. This preceded any moves in policy rates. In addition, many rapidly growing economies have been forced to tighten monetary policy despite the weak growth as a result of external pressures.

Significant underperformance of equity markets — RGM equity markets have fallen by around 5% since the start of 2013. In contrast, the US Standard & Poor's index has risen by more than 15% over the same period.

While some RGM currency and equity markets have started to recover, the impact of falls in the financial markets will be felt for some time. The fall in currencies and rise in risk premiums in RGMs have added to the challenges, especially as weaker currencies add to inflationary pressures.

Higher borrowing costs will weigh on investment and consumption.

Medium-term challenges moving into view

Substantial medium-term challenges across a number of leading RGMs are becoming increasingly clear.

However, many responses have been too focused on trying to slow the currency falls. Not enough emphasis has been put on policies to boost medium-term growth.

Some RGMs better placed to implement reforms

Certain RGMs have made significant progress in addressing their medium-term sustainability.

In June, Indonesia improved its fiscal position by reducing fuel subsidies. The Government has said that three-quarters of the estimated US$1.8b of savings that result will be spent on infrastructure under the 2014 budget.

The reduced burden of fuel subsidies should also make for a more stable macro environment and enhance Indonesia’s attractiveness for investors.

Nonetheless, the rupiah is one of the few RGM currencies that did not gain much ground against the dollar in September. Investors may be underweighting some of the progress that Indonesia has made.

To achieve growth of 5.5% by 2016, RGMs will need to achieve a political consensus around economic reform.

Over the next three years, we will see more divergence in growth prospects between those RGMs that are willing and able to implement growth-boosting economic reforms and those that are not.

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